Abstract
In this chapter, we develop a model to determine the equilibrium value of the real exchange rate, by extending the intertemporal model of the current account described in Chapter 4 to include nontradable goods. We start by showing the relation between the real exchange rate and the price of nontradable goods. We derive the relation between the equilibrium real exchange rate and the current-account balance, and we show that a more depreciated real exchange rate is associated with a higher current-account balance. Finally, we show how the real exchange rate responds to shocks to the economy.
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